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The Sources and Sustainability of China's Economic Growth

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The Sources and Sustainability of China's Economic Growth 10269-01_Jefferson-rev.qxd 1/29/07 10:56 AM Page 1 GARY H. JEFFERSON Brandeis University ALBERT G. Z. HU National University of Singapore JIAN SU Peking University The Sources and Sustainability of China’s Economic Growth IN 1978, AT THE outset of its economic reform, China was the world’s tenth- largest economy, with a GDP of about $150 billion, or less than 6 percent of U.S. GDP at the time. By 2005, however, China’s economy, at $2.2 trillion, had grown to become the fourth largest in the world, behind only the United States at $12.5 trillion, Japan at $4.5 trillion, and Germany at $2.8 trillion. The above figures, which come from the World Bank, evaluate GDP at current exchange rates and do not take account of differences in the pur- chasing power of currencies. When measured instead at purchasing power parity (PPP), China is already the world’s second-largest economy, with almost $9 trillion in output, nearly three quarters that of the United States. It has been suggested that, at current growth rates, China’s GDP stated in PPP terms could exceed that of the United States as early as 2010.1 When China’s GDP converted at current exchange rates does match that of the United States, assuming that China’s population remains four times the U.S. population, Chinese income per capita will then be but one quar- ter that of the United States. By comparison, the purchasing power of the average Chinese resident will substantially exceed one quarter that of the average U.S. resident, perhaps rising to the vicinity of one half. The authors appreciate their research collaboration with China’s National Bureau of Statis- tics and specifically with its staff members Liu Yaodong and Qian Jinchang, who helped with data formatting and offered guidance on aspects of the research presented in this paper. We also appreciate the excellent research assistance of Sun Xiaole and Zhao Yan, doctoral candidates at the International Business School at Brandeis University. We acknowledge the support pro- vided by the National Science Foundation (award no. SES-0519902) that helped support the research assistance provided to this project. Finally, comments provided by Barry Bosworth and Gustav Ranis during the panel session were most helpful for revising the paper. 1. See, for example, Holz (2006, p. 41). 1 10269-01_Jefferson-rev.qxd 1/29/07 10:56 AM Page 2 2 Brookings Papers on Economic Activity, 2:2006 What changes will have to occur within China’s productive sectors for China’s GDP to match and ultimately surpass that of the United States? Today even China’s coastal industry, the country’s most techno- logically advanced region and sector, lags substantially behind the world technology frontier. Meanwhile a well-known feature of China’s rapid economic transformation is the unequal advance, in terms of technolog- ical change and productivity, of different regions and sectors across this large and populous country. The regions and sectors that lag behind China’s coastal industry also exhibit large disparities in productivity among themselves. These large international and internal productivity gaps represent both advantages and disadvantages for China’s ability to sustain high rates of GDP growth. The key advantage is that both the international gap and the internal gaps continue to provide multiple channels through which catch-up can proceed. A well-known disadvantage of the internal gaps is that the accompanying large differences in income threaten social stabil- ity. A further disadvantage of large internal productivity differences, to the extent they prove persistent, is that much of the burden of China’s catch-up with the United States will fall on coastal industry. That is, if productivi- ties in the regions and sectors outside China’s coastal industry remain far below one quarter that of the United States, then coastal industry will have to achieve productivity levels well above one quarter that of the United States. Coastal industry will have to continue as the locomotive pulling the rest of the economy forward. Indeed, if China is to meet its ambitious goal of output parity with the United States, productivity in coastal indus- try may have to closely approach or even exceed U.S. productivity. Yet the history of other successful developing countries suggests that, as it does so, China’s productivity growth is likely to slow substantially, in turn slowing the country’s overall economic growth. A number of questions emerge from this overview and frame the analy- sis in this paper: Within China, how much does China’s coastal industry lag behind the global frontier? How much do China’s other regions and sectors lag behind coastal industry? Is there evidence of catch-up or con- vergence of these regions and sectors with coastal industry? If so, what are the sources of such change? If instead there are growing disparities, what are the causes? To what extent can one expect that, as China’s coastal industry closes in on the global technology frontier, the productivity growth of China’s own technology frontier will slow? 10269-01_Jefferson-rev.qxd 1/29/07 10:56 AM Page 3 Gary H. Jefferson, Albert G. Z. Hu, and Jian Su 3 We investigate these questions using panels of industry and firm- level data. However, any research agenda that seeks to assess a country’s medium- to long-term economic growth prospects has to take into account that country’s capacity for institutional adaptation, since institutions shape the incentives and prospects for such growth. This is particularly true for China, which remains engaged in two transitions simultaneously: from a centrally planned to a market economy, and from a less to a more devel- oped country. Therefore we also speculate as to what institutional reforms will most directly bear on China’s ability to close its international and internal productivity gaps. These reforms depend on the ability of China’s political system to formulate and enforce the rules that reassign and clar- ify the property rights needed to sustain investment in technology devel- opment and to facilitate the flow of resources to the regions and sectors offering high returns. During the past quarter century of reform, and largely to the surprise of most observers, China’s economic performance has demonstrated con- siderable resilience. In addition to successfully weathering the Asian financial crises of the late 1990s, China has substantially restructured its state enterprise sector and opened itself to the international economy, including by having adopted World Trade Organization (WTO) rules. For two decades now China has sustained an annual average rate of growth of GDP about 6 percentage points higher than that of the United States (about 9 percent versus 3 percent). If China can sustain that growth advantage into the future, then, assuming no change in exchange rates, its GDP unadjusted for PPP will catch up to that of the United States in twenty-five to thirty years. When China’s GDP does catch up to U.S. GDP, that fact will be of more than symbolic importance. Having established an economic system that is as large, if not as efficient, as that of the United States, China’s consumption of natural resources, its participation in the international trading and financial systems, its contribution to global technological advance, and its influence in international relations and conflict man- agement are likely to approach and in some cases exceed those of the United States. The paper is organized as follows. The next section describes the basic model, partly inspired by Edward Denison’s work, that we use to organize our analysis of China’s catch-up prospects. We next examine the magnitude of the relevant productivity gaps, and we focus on the Chinese 10269-01_Jefferson-rev.qxd 1/29/07 10:56 AM Page 4 4 Brookings Papers on Economic Activity, 2:2006 economy’s dynamic catch-up processes for reducing both the international and the internal gaps. We then combine our empirical findings to discuss the prospects and challenges for China’s GDP to catch up with that of the United States during the next twenty-five to thirty years. As already sug- gested, any analysis of China’s catch-up prospects over such a horizon must take into account the role of institutions, including both the con- straints they set and the opportunities they offer for shaping the pace at which the relevant productivity gaps are reduced. Finally, we focus on the political economy of China’s economic growth, and we draw various con- clusions from our analysis, including some policy implications. The Basic Model: Two Productivity Gaps In his study of the process by which living standards in the major non- U.S. industrial economies narrowed the gap with, and ultimately caught up to, those in the United States, Denison identified several sources of this catch-up, three of which he viewed as key: resource reallocation, scale economies, and movement toward the international technological frontier (table 1).2 In his study of China’s long-run performance, Angus Maddison cites these same three sources of long-run growth: Countries in this situation of relative backwardness and distance from the technological frontier have a capacity for fast growth if they mobilise and allocate physical and human capital effectively, adapt foreign technology to their factor proportions and utilise the opportunities for specialisation which come from integration into the world economy.3 A close examination of Denison’s results suggests the following lessons: —Within the current group of advanced industrial countries (members of the Organization for Economic Cooperation and Development, or OECD), labor productivity in the initially poorer countries grew faster than it did in the richer countries—a necessary condition for catch-up.
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